Updated from 3:32 p.m. EDTStocks fell in concert with the dollar Monday after Treasury Secretary John Snow effectively abandoned the so-called strong dollar policy or, at least, gave tacit approval to the greenback's recent weakness. On Saturday at a meeting of finance ministers from the Group of Eight major industrialized nations, Snow said the dollar's fall in the past 15 months has been "a fairly modest realignment," and that the strong dollar policy refers to it being "hard to counterfeit," among other things unrelated to its market value. Amid the stock market's rally since mid-March, many bulls cited the salutary effects of a weaker dollar as an underpinning for the advance, notably improving earnings of multinational corporations. All that changed Monday, although complacency about the significance of a weaker currency remains intact. In part because of the dollar's weakness, the Dow Jones Industrial Average fell 2.1% to 8493.39, the S&P 500 shed 2.5% to 920.77 and the Nasdaq Composite lost 3% to 1492.80. The good news is there was no panic evident Monday in either stock or currency trading, although the dollar ended sharply lower vs. the euro (see below). Equity trading volume was down from recent levels, suggesting no rush for the exits, although pretty solid for a Monday at 1.35 billion shares on the Big Board and nearly 1.7 billion in Nasdaq trading. The bad news is there wasn't more evidence of concern among traders and market watchers about the significance of the dollar's weakness, much less the recent spate of terrorist bombings in the Middle East. Although the CBOE Market Volatility Index rose 9.7% to 23.04, its Nasdaq counterpart rose a scant 0.3% to 31.10, suggesting traders' continued faith in the recent tech-led advance. Most observers seem to think this setback in shares is a natural retracement of gains registered since the mid-March lows and nothing to get too upset about. Meanwhile, strategists such as Thomas McManus, an equity portfolio strategist at Banc of America Securities, continue to urge traders to "buy the dips," in part because "we still anticipate upside surprises because of a weaker dollar, lower energy prices and fiscal stimulus." Pundits from RealMoney.com's Jim Cramer to The New York Times' William Safire echoed this "a weaker dollar is good" viewpoint. Those folks may be right, but after marching higher in lockstep through the late 1990s, it seems unlikely the dollar and stocks can now proceed in the opposite direction for very long. To reiterate, panicking is bad, but sometimes a little worry is justified. "By appearing to embrace a weaker dollar, they're removing safety nets," said David Gilmore, economist and partner of Essex, Conn.-based Foreign Exchange Analytics. "Pull those out and you're on the high wire with nothing to catch a collapsing dollar." As alluded to in a RealMoney.com
"Asia is a big trouble spot, because everything is dollar linked," said Greenwald, suggesting the yen is also linked to the greenback, albeit not formally, because of the Bank of Japan's policies. As a currency trader, he hopes the Chinese allow the yuan to float but believes it won't happen anytime soon. A weaker yuan "doesn't mean the risk of capital flight" from China right now, he said. But going forward, "it's a big issue," he continued. "Europeans will say 'we've done our part. U.S. goods are flowing in, so how come you're not selling in Asia?' Meanwhile, those European countries will be flooded with cheap Asian goods." Such a scenario brings us to "the possibility of competitive currency devaluations aimed at short-circuiting the very process of global rebalancing," as Stephen Roach, chief global economist at Morgan Stanley opined Friday. The economist correctly forecast the Japanese authorities would "draw a line in the sand" when the dollar approached 115 yen -- as occurred Monday -- and suggested a euro move into the $1.25 range would prompt a similar response from European authorities. "With the European and Japanese economies in bad shape, the risk is that authorities in those countries believe that they, too, are deserving of the weaker currency," Roach continued, suggesting the nation with the largest current account deficit -- in this case the U.S. -- has historically ended up with the weaker currency. "To the extent that Japan and eventually Europe can put a limit on currency realignment, the immediate imperatives of structural reform would then be lessened. And the politicians would then avoid the necessity to embrace reforms, thereby surviving to serve yet another term." Many would argue the Bush administration is adopting policies aimed at weakening the dollar -- or lessening its robustness -- for those very same political reasons. Roach's point is that a weaker dollar is an unavoidable necessity to bringing about global rebalancing "away from U.S.-led excess demand" -- which has prevailed since the mid-1990s -- "toward more support by domestic demand from Europe, Japan, and even the developing world." To the extent officials in Europe and Japan resist such a rebalancing -- either because of short-term considerations or (as in Europe) policy mandates that inhibit looser monetary policies -- "the imbalances of a lopsided global economy can only intensify," Roach concluded. "That would make for an even nastier endgame." In some regards, Snow is right and the dollar's weakness so far has been fairly modest -- the Dollar Index is only down about 8% so far this year. Perhaps more dollar weakness, provided it remains
orderly as the recent decline has largely been, including Monday, will spur more positive results for the U.S. economy and equity markets, helping boost economic growth worldwide. However, if Japanese officials -- and ultimately their European counterparts -- attempt to fight the dollar's decline and a "race to the bottom" among major currencies results, financial assets around the globe are likely to suffer greatly. Notably, gold futures rose 3.5% to $367.10 Monday while the Philadelphia Stock Exchange Gold and Silver Index rallied 3.1%.